Today, the SEC announced that they have brought charges against Luca International, an oil and gas company that operates in the Bay Area, California. Government regulators allege that the company was operating as a Ponzi-like scheme and affinity fraud that ultimately stole and estimated $68 million from investors. In addition to Luca International’s charges, the US government has filed charges against Luca CEO Binging Yang, for allegedly orchestrating the fraud and openly misleading investors on the state of the company.
CEO Yang allegedly overstated Luca International’s oil reserves and investment returns
Detailed in the press release, the SEC details how Luca International was allegedly preying on Chinese-Americans and Chinese immigrants using the EB-5 Immigrant Investor Program. The charges detail how Yang would over exaggerate Luca’s holdings and oil reserves by a substantial margin (despite the company’s mountain of debt and lack of earnings) and later diverted $2.4 million of investor funds to her personal accounts. While the money was supposed to buy a new oil rig, it actually bought CEO Yang a nice, gated, 5,600 sq. foot home in Fremont, CA. Additionally, the complaint details of investor money being used to pay for Yang’s personal taxes, pool maintenance, gardening, and even a family vacation to Hawaii. Luca International allegedly targeted the Chinese-American community in California through extensive advertising campaigns through TV ads, newspapers, radio, etc.
SEC brings charges against Luca’s employees for their role in the fraud
While Binging Yang is the SEC’s main target in this case, the government regulator also brought charges against former VP of business development Lei Lei, “who allegedly sold securities to investors and helped Yang divert investor funds,” (SEC). Former CFO Anthony Pollace was able to reach a $25,500 settlement with the government on charges of his role within the fraud. Yong Chen was allegedly able to raise investor equity through a separate company called Entholpy EMC, and thus has also been implicated in this case as an important part of the fraud. Lastly, Hiroshi Fujigami and Wisteria Global, his company, were able to reach and agree to a settlement with the US government, in which the company would return the $1.1 million in profits it gained from the fraud and Fujigami agreed to terms of being barred from the financial services industry.
Once estimated to be a billion dollar company by 2018, the company’s future looks extremely bleak after evidence of fraud has been uncovered by the SEC. “LUCA will be a world-class oil and gas company driven by shared commitment to excellence,” states the CEO’s Message on the Luca International website.
Trust can be fleeting – especially the trust we instill in leaders. A leader might spend 30 years building trust, and then watch it disappear in 30 minutes if he’s not careful. And when leaders flagrantly violate trust, it’s often never recovered.
Consider the epidemic of distrust caused by leaders putting their self-interests above all else. You’ll even hear some economists argue that this makes sense, because we’re all motivated by money and that’s just how the market functions.
Well, I disagree. Greed is not the market operating. Greed is actually disgraceful. But unfortunately, many leaders get away with it. Then all the people that depend on them—customers, shareholders, communities—are betrayed. Often a whole enterprise is destroyed.
To me, if you’re privileged enough to be in a position of leadership, it is paramount that you maintain the trust of the people for whom you have a responsibility. And if you violate that, then you have failed.
Now, here’s the catch. We all fail. But we can recover. Leaders can bounce back, but they have to prove themselves. I like to think that the virtues you live by when things are going well don’t matter.
The real test is how you behave when times are tough. And if you’re a leader, your constituents want to see what you do under severe pressure. If you can stay true to your values then, people will trust you again. You’ll be viewed as authentic.
[Watch Bill George explain why difficulty is an opportunity.]
In fact, there’s a correlation between being an authentic leader and getting great results.
Here’s an example. When Anne Mulcahy—former CEO and chairperson of Xerox—was faced with bankruptcy, she reconfigured the whole company and made some really daring decisions. She decided not to cut R&D, not to cut customer support, but to invest in the long term. They ultimately had to trim up and have fewer employees in the end, but they came back. They avoided bankruptcy and achieved great success, in fact. And Mulcahy didn’t have finance experience – she rose through the ranks, starting as a salesperson out of college. Authentic in her virtues and loyalty to Xerox; she made many bold decisions and went on to be voted one of America’s Best Leaders by US News and World Report in 2008.
How to Build Trust
So how can you do this? It requires a few qualities.
You’re willing to get experience doing the work of your team. This doesn’t mean giving rousing speeches, putting out strongly worded press releases, or releasing polished promotional videos. This means you actually spend time with the people doing the work.
You honor those people by listening and responding in earnest.
When I was at Medtronic, I gowned up and saw between 700 and 1,000 procedures. I’d put on the scrubs, met with the doctor, and watched an open-heart surgery, a brain surgery, or a pacemaker implant. And that’s how I learned the business.
When I was on the board of Target Corporation, the former CEO, Bob Ulrich, explained how he walked about 14 store floors a week. He didn’t tell them he was coming. He just put on a sweatshirt, walk around, and watch the store run.
And take Dan Vasella at Novartis. He’d be down in the labs all the time with the researchers asking, “What are you working on? What are the barriers?”
Instead of being the invisible entity who spends his or her time at black tie CEO events in DC, this is a leader who delves into the real day-to-day functions of the business. And that’s the type of leader who builds trust.
To maintain that trust, you need care about your team, want to be out there with them, and love the business. You really do have to love it! I can’t stress that enough. If you don’t love it, don’t do it.
This study reveals through lab experiments a hitherto-undocumented form of gambling: Participants in a decision-making task exposed themselves to extreme levels of tail risk to pick-up additional pennies. The data offer suggestive evidence that the root cause of this behavior is greed — participants could not resist the temptation to seek more dollars despite knowing the risks entailed. The findings of follow-up experiments provide a hurdle to other explanations and a means of validating the greed hypothesis. These findings are surprising both due to the pervasiveness of the picking pennies behavior in the lab and its robustness.
Picking Pennies Bias: Exposing Oneself To Tail Risk – Introduction
In this paper I report on a novel behavioral bias which consists of exposing oneself to mindless levels of tail risk to win additional dollars—henceforth, “the picking pennies bias.” I build on recent results obtained in a lab experiment designed to study learning under tail risk (Payzan-LeNestour, 2016). In that experiment, task participants were to choose to bet in Normally-distributed reward prospects, which by design had positive expected value, while avoiding negatively-skewed ones, which yielded steady streams of good outcomes but eventually inflicted a major loss that annihilated all
previous gains. The task comprised several sessions of 20 trials each. In some of the sessions the prospect was of the Normal kind, in others it was negatively-skewed. At the beginning of each session the participants did not know which kind of prospect they were facing, however they could learn about it through observing the value generated by the underlying prospect in each of the 20 trials of the session. In the process of studying participants’ learning in the experiment, I discovered a novel behavioral bias: a group of participants bet after observing an extreme value whose realization made it clear that the underlying prospect was of the bad kind.
In this study I begin by analyzing in depth this behavior as it emerged in the data used in Payzan-LeNestour (2016). I show that in view of both those data and the existing neurobiological evidence from prior work, the most plausible explanation for the picking pennies bias is that task participants bet despite knowing the risks entailed, because they could not resist the temptation to seek more dollars through betting—“the greed hypothesis.”
While the analysis offers suggestive evidence supporting the greed hypothesis, it can only partially rule out the possibility that the picking pennies bias reflects instead learning failures (erroneous beliefs about the prospect kind) or risk-loving preferences in the subjects, as the original experiment was not specifically designed to flesh out the root cause of the bias. The current study sets out to do this. I
ran two follow-up experiments. The first allows me to exclude learning failures and risk-loving preferences as potential explanations, by neatly disentangling beliefs and preferences. The second constitutes a litmus test of the greed hypothesis in that it directly tests one of its key implications, namely, the idea that those subjects who picked pennies in the task could not help betting, i.e., their behavior was at variance with deliberation.
The first experiment replicates the conditions of the original one except that just before each session began, the subjects were told the nature of the prospect in the session, whereby there was no learning involved in that experiment. I find that the picking pennies bias prevails to the exact same extent as in the original experiment. It cannot, therefore, be attributed to learning failures. This finding also fully rules out the risk-loving explanation (I elaborate in Section 3.1).
The second experiment slightly augments the original task in that the subjects in each trial were also given the option to either bet or not bet (“skip”) in all of the remaining trials of the session. I find that the subjects made extensive use of the option to skip for all trials. Thus, when betting was suboptimal during the task, subjects effectively bound themselves to not betting. Such “self-binding” is reminiscent of Ulysses’ reliance on an externally imposed constraint to resist the call of the sirens (Elster, 1979). I further find that in that treatment, the prevalence of the picking pennies bias is significantly reduced. This result compellingly suggests that task participants were drawn to the picking pennies bias because of greed coupled with limited self-control. As such, it considerably strengthens the evidence for the greed hypothesis.
Finally, I find that the picking pennies bias cannot be ascribed to limited liability in the lab—the fact that task participants are not exposed to actual potential losses. Limited liability is a general concern in all experimental designs involving potential losses, as the rules imposed by the ethics committees are very strict in terms of not harming participants, so inflicting actual losses to participants is usually not authorized within our standard experimental procedures. I devised a new payment procedure (explained in detail in Section 4.3) that allowed me to expose subjects to real losses while complying with the ethics rules. In a third and final follow-up experiment that used that procedure, the picking pennies bias prevailed to the same extent as in the previous experimental sessions. It thus appears to be surprisingly robust.
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Financial advising is a natural fit for rational, analytic professionals who think from a place of logic.
At least, that is how the field is often seen.
But your clients make their decisions, including which advisor to entrust with their financial concerns, from a place of emotion. By understanding the psychology behind your clients’ state of mind, you can improve and strengthen client relationships, anticipate their needs and predict their future behaviors.
There is a subtle, but significant, difference between managing a portfolio and managing all of a client’s needs and expectations. Given the geopolitical tensions and market volatility clients have faced this year, it has never been more important to understand what is driving them to act the way they do. Too often, advisors think only from a technical perspective. They rarely realize until it’s too late that a great technical solution to a financial problem may be emotionally unacceptable to a client.
Likability, competence and trust are the criteria that most clients base their decision on when choosing a financial advisor. Trust, the most important of these three, is what keeps clients happy and loyal over the course of years. Financial advisors must get to the bottom of the needs of their clients on every level – that’s where trust is built, and that’s where advisors will be able to actually do what they do best and provide advice that will be heeded and, beyond that, valued.
Let’s look how advisors can identify the three basic motives underlying client behaviors.
What drives client behavior?
Every client has a goal. While on the surface it may appear to be something simple ,such as save for retirement or preserve capital, there is always an underlying cause influencing what their goals are and the path they are most comfortable taking to reach them. This becomes especially evident in times of uncertainty. In the face of strong emotions, reason and logic depart from the equation. It sounds simple enough on paper, but it is also why many clients buy high, sell low or cash out at the wrong time. No matter the science, they will blame their financial advisor when the results aren’t what they were expecting.
A client put into an uncomfortable situation will cease thinking with their pre-frontal cortex or “thinking brain,” and their primitive brain will take over. They revert to their primal instinct of flight, fight or freeze. The context and the temperament of the individual determine their default approach. The goal of an advisor shouldn’t be just to stop clients from irrational reactions; it is paramount that advisors acknowledge the symptom, analyze the client’s unique situation and delve into addressing the underlying cause.
There are three basic drivers of influence. The next step is to identify which is piloting a client:
Greed – Pleasure seeking
Clients whose instincts are driven by greed are more open to taking risks with their financial strategy and are in search of short-term gains. They want instant gratification, measurable returns and may not excel at looking at the long-term big picture. They are more opportunistic and are looking for their advisor to suggest avenues that will lead to a quick buck.
Fear – Pain avoidance
Clients who operate under the driver of fear are afraid. They are afraid of losing money and anxious about incorporating risk into their portfolios. These are clients who perhaps have not moved very often or who have a large number of financial obligations. Panicking at headlines and selling low is one example of a typical response from these clients.
Ego – Preserving status
Clients operating under the driver of ego are working to build or preserve their social standing. They are seeking to “keep up with the Joneses” and are in search of bragging rights. Growing their wealth to purchase big-ticket items and holding onto those status symbols is more important to them than the necessary actions that will fortify their financial future.
A Short Course On Fear And Greed: Successful Investors Wrote The Book by Guy Christopher, Originally Published on Money Metals Exchange
Are you a millionaire yet? Me neither.
A Short Course On Fear And Greed
We might have been by now, had we better understood the finer points of “fear” and “greed” during our investing lives.
“Greed, for lack of a better word, is good,” said fictional corporate raider Gordon Gekko, played by Michael Douglas in 1987’s “Wall Street.” The quote became a rally cry for the 13-year stock market surge following the October ’87 crash.
Fear, on the other hand, can be just as influential in charting investments.
“I have only two positions right now – cash and fetal,” wailed investor Jeff Mackey, staring wide-eyed into CNBC’s cameras on October 2, 2008. The subprime mortgage crisis was in full cascade mode, as the stock market meltdown washed banks and balance sheets over the cliff.
Greed was clearly not Gekko’s best idea. He went to prison for insider trading, alongside a couple of the very real characters he was based on.
In hindsight, Mackey was terrified of losing money one year too late. Stocks had started tanking exactly 51 weeks earlier, from a high of 14,164 on the Dow, ultimately suffering a 53% disaster. That was peanuts compared to the 90% losses to the Dow stretching over the years of The Great Depression, but for modern investors, bad enough.
Obviously, market tops and bottoms are recognized only in the rear view mirror. It takes time for hard facts to illustrate the equations, which means this stuff is never that easy.
After a five-year fall from the highs of 2011, metals have been rising in dollar terms since mid-December, with a headline-grabbing hike the night of Great Britain’s historic Brexit vote to leave the European Union.
This week, both gold and silver took hard hits in dollar terms, causing stress for some precious metals stackers. And that’s the perfect classroom for today’s lesson, where we have some excellent teachers lined up.
British commodities trader Andrew Maguire is the fellow who demonstrated bullion bank price manipulation to the world with his testimony to the Commodity Futures Trading Commission (CFTC) in 2010.
Maguire correctly identified intricate price changes hours before they happened, because he knew where the fix was in.
He now says the dollar-price take down earlier this week was artificially engineered by bullion banks to cover losses in the paper metals markets.
In other words, gold and silver were brought down in dollar terms through greedy, political manipulation, not by a loss of intrinsic value, and not by a loss of trust in metals.
The classic lesson of fear and greed comes from The Battle of Waterloo, where French Emperor Napoleon Bonaparte was whipped by the British in 1815.
Nathan Mayer Rothschild had bankrolled much of Great Britain’s war against Napoleon, and had everything to lose if Napoleon won. Early reports from the battlefield convinced the London stock market Napoleon had been victorious, which led to widespread panic selling. But Rothschild had his own observer watching the battle, and reporting privately to him.
Knowing the British had won, he mopped up everything at sacrifice prices from terrified sellers.
The story, which some historians believe has been embellished, gave us the adage “buy when blood is running in the streets.”
What is undisputed – of all the wealthy investors of that era, the one name surviving 200 years as a modern household synonym for massive wealth is “Rothschild.”
Buying low isn’t easy. It means going against the crowd. But it you think that’s hard, try selling high, when everything looks just great, before blood runs in the streets. Either strategy makes you a “contrarian,” which means your intellect has overcome the emotional clutches of fear and greed.
We know today the stock and bond markets have been stitched together and driven higher by free money from central banks funneled to Wall Street, all in a government effort to make the economy seem healthy when it’s not.
As Money Metals has been reporting for months, disciplined movers and shakers, one after another, are taking their money and leaving the stock and bond markets, dropping well-reasoned warnings of economic catastrophe along the way.
And incidentally, many of them also report they are stocking up on gold.
Is there a way to corral fear and greed? The answer is yes, if you’re talking about gold and silver.
See metals for what they really are – as solid savings in the only intrinsically valuable currency – and not as financial investments. Fear only enters the picture when you count gold and silver in dollar terms.
As for greed, that depends entirely on how many ounces and grams you can get for your paper money.
A reliable teacher in buying low and selling high is China, the world’s leader in reshaping the modern gold story.
The Chinese have patiently been buying low for perhaps decades, as other nations and investors lost interest in gold. As for selling – the Chinese are still hanging onto their gold. They aren’t selling.
So, how should sellers approach fear and greed? If you see gold and silver as investments, then sell when you’re ahead in dollar terms.
If you see gold and silver as savings, as insurance against calamity, then sell when there’s something you want more than your savings and insurance.
Money Metalscolumnist Guy Christopher is a veteran writer living on the Gulf Coast. A retired investigative journalist, published author, and former stockbroker, Christopher has taught college as an adjunct professor and is a veteran of the 101st Airborne in Vietnam.
Delivering the Keith Joseph Memorial Lecture last week, Matt Ridley highlighted a common, yet unfounded, attack on free markets: that they encourage us to be greedy and selfish, and erode moral values.
No hard evidence is ever offered to prove that free markets encourage greed.
Get The Timeless Reading eBook in PDF
Get the entire 10-part series on Timeless Reading in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.
By Unknown, signature indecipherable. [Public domain], via Wikimedia CommonsAlexas_Fotos / PixabayThis has been a frequent lament from the Left, who pivoted in the 1980s from claiming Margaret Thatcher and Ronald Reagan’s free market agenda would slow growth to saying that it encouraged us to want too much.
The US philosopher Michael Sandel has argued that the infusion of markets into many areas of life has led to the crowding out of virtues such as altruism, generosity and solidarity. The Pope has said that “libertarian individualism . . . minimises the common good”. Bizarrely, even UK Conservatives appear to agree. The 2017 Conservative manifesto declared: “We do not believe in untrammelled free markets. We reject the cult of selfish individualism”.
The weird thing about all these assertions is that no hard evidence is ever offered to prove that free markets encourage greed. That may be because the evidence – and logic – suggest that the opposite is true.
“Proof” of Capitalist Selfishness
First, let’s state an obvious truth. There appears to be a robust and strong relationship between levels of prosperity and economic freedom. Natural experiments, such as East and West Germany, North and South Korea, and Hong Kong and mainland China, have shown that market economies tend to be much more prosperous than non-market economies.
"No one would remember the Good Samaritan if he’d only had good intentions."
This results in more resources for compassionate causes, whether through individual activity or socialised through the collection of tax revenue. It can be said quite clearly that free market economies facilitate the opportunity to be more compassionate. As a British Prime Minister once said, “no one would remember the Good Samaritan if he’d only had good intentions; he had money as well.”
But opportunities need not be taken, of course. So what does the empirical literature suggest on whether markets facilitate greed and lead to selfish immoral behaviour?
In a famous paper in 2013, Armin Falk and Nora Szech purported to show that markets norms did in fact damage us. They ran experiments involving cash, giving participants in the experiment the option of paying to save a mouse from being killed. They found that people were more likely to enable the killing when the decision came about as a result of bargaining between buyers and sellers (which made the mouse a third party), rather than someone making an individual decision based on the mouse-cash trade-off alone.
They concluded that “market interaction displays a tendency to lower moral values, relative to individually stated preferences,” perhaps because of the ability to spread the guilt between trading parties, or because of the “competition” for money.
Building Trust and Tolerance
This study went around the world as “proof” that markets eroded our humanity. But closer examination of the results suggested something quite different. In this game, there was no clear good being traded, except the abstract thought of a mouse dying. In the real world, most transactions are more like the individual judgment rather than bargaining. We walk into a store or market as a price-taker and decide whether or not to buy a product.
This would suggest the interpretation given by Falk and Szech could be the the opposite of what the results suggest. As Breyer and Weimann concluded in their critique of the original paper, “in typical market situations, moral norms play a more prominent role than in non-market bargaining situations” that tend to be zero-sum.
Markets encourage collaboration and exchange between parties that might otherwise not interact.
This alternative interpretation is backed up by the experimental work of Herbert Gintis, who has analysed the behaviours of 15 tribal societies from around the world, including “hunter-gatherers, horticulturalists, nomadic herders, and small-scale sedentary farmers – in Africa, Latin America, and Asia.”
Playing a host of economic games, Gintis found that societies exposed to voluntary exchange through markets were more highly motivated by non-financial fairness considerations than those which were not. “The notion that the market economy makes people greedy, sel?sh, and amoral is simply fallacious,” Gintis concluded.
This makes sense. Considering the broad sweep of history, one can observe that the rise of market economies and the greater material wealth they have brought has largely coincided with a greater tolerance of others, including less willingness to exploit. As Gintis again summarises, “Movements for religious and lifestyle tolerance, gender equality, and democracy have ?ourished and triumphed in societies governed by market exchange, and nowhere else.”
In other words, we might expect greed, cheating and intolerance to be more prevalent in societies where individuals can only fulfil selfish desires by taking from, overpowering or using dominant political or hierarchical positions to rule over and extort from others. Markets actually encourage collaboration and exchange between parties that might otherwise not interact. This interdependency discourages violence and builds trust and tolerance.
What About Mixed Economic Systems?
Now, at this stage, I’m sure that many people who consider themselves moderate socialists would object. Of course, they might say, there is a role for markets. But modern economies are mixed, compromising some relatively free markets and other areas with extensive government intervention. The “longer individuals were exposed to socialism, the more likely they were to cheat.”
Most countries have different cultures too, so comparing whether more “free market” or “socialistic” countries are likely to promote and encourage greed is very difficult. Gintis’s experiments are interesting, but do they really inform us about whether shifting the balance from markets towards state provision would lead to negative effects in terms of a less trusting or more greedy society?
Well, we cannot say for sure. But sometimes natural experiments arise which give us suggestive insights, and the most obvious recent example was the split of Germany into a broadly capitalist West and the socialist East.
In a 2014 paper, economists tested Berlin residents’ willingness to cheat in a simple game involving rolling die, whereby self-reported scores could lead to small monetary payoffs. Participants presented passports and ID cards to the researchers, which allowed them to assess their backgrounds.
The results were clear: participants from an East German family background were far more likely to cheat than those from the West. What is more, the “longer individuals were exposed to socialism, the more likely they were to cheat.”
All of which suggests that the conventional trendy wisdom is wrong. Free markets do not make us greedy and immoral. But embracing socialism may well do.
Defenders of free markets often do more harm to their cause than detractors. One of the first of these defenders, the 18th C satirist, Bernard Mandeville, makes two fundamental errors in his argument for free markets. He equates self-interest in the economic realm with greed, and he fails to realize that the so-called “private vices” of greed and vanity have social costs that make them, at best, very mixed “public benefits.”
Get The Timeless Reading eBook in PDF
Get the entire 10-part series on Timeless Reading in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.
By Unknown, signature indecipherable. [Public domain], via Wikimedia CommonsIn his infamous story, "The Fable of the Bees; or, Private Vices, Publick Benefits" (6th ed., 1729),Mandeville proclaims that the great advancement in people’s welfare in the early 18th Century is due to the vices of the wealth-creating individuals. Vanity and greed motivate people to work hard and produce. Consequently, discouraging vice and encouraging honesty and other virtues are foolish as it leads to poverty. If we want “the hive” to be “a paradise,” we should want it to remain full of vice (The Fable, Vol. I, pg. 31).
It is true that vanity and greed can lead an individual to work hard and become rich. But there is no reason to believe that these traits are the best motivators of hard work and wealth, or that if most people were motivated thus, society would become wealthy. Mandeville’s claims rest on his crude, unnuanced conception of vice (and virtue).
Greed and Vanity
He labels all desires and actions to produce wealth beyond subsistence level as greedy, instead of only those that (in Aristotelian language) are excessive in some way. These include desires and actions that lead you to step over other people, or act dishonestly, or break your word, or devalue your family and friends, all for the sake of making more and more money.
Mandeville seems to think that the only alternative to greed is self-sacrifice, which is rather like thinking that the only alternative to gluttony is starvation, or that the only alternative to cowardice is recklessness. His moral psychology leaves no room for rational self-interest, or for recognizing that working and creating value is a fundamental need for most people even when it doesn’t lead to great wealth. Examples abound: think of entrepreneurs who risk all their savings on a new cafe, or a new app, or a DNA testing service, or a “tiffin” service for office workers in Mumbai. Mandeville sees no intellectual or moral virtue in such entrepreneurship, or in carrying out a task well because, in his view, they are all motivated by greed and vanity.
This conflation of greed with self-interest harms the cause of free markets.
Mandeville also indicts honesty as detrimental to the economy in an argument that shows his poor grasp of a fundamental principle of economics: opportunity cost. In an early version of what Frédéric Bastiat later called the broken window fallacy, Mandeville argues that if everyone became honest, locksmiths and lawyers would lose their jobs and society would be harmed. What he overlooks is the loss to the victims of dishonesty, and the fact that, if there were no dishonesty or other vice, people would use the money they saved on locks and lawyers to lend or spend on services or consumption goods – provided, among others, by the erstwhile locksmiths and lawyers. The result would be the creation of far greater value for everyone involved than if people had to buy locks or lawyers in self-protection. Dishonesty creates a deadweight loss, and widespread dishonesty hinders or renders impossible ongoing cooperation and success in the marketplace.
Mandeville’s view that private vice leads to public benefit might even be incoherent. If it’s greedy to want more than the bare minimum, then prosperity cannot be an unmixed public benefit. It’s a public benefit to the extent that it relieves the lot of the poor, but if Mandeville is right that prosperity feeds people’s greed and vanity, it’s a harm, not a benefit. In “The Grumbling Hive” Mandeville says:
“Vast Numbers throng’d the fruitful Hive;
Yet those vast Numbers made ’em thrive;
Millions endeavouring to supply
Each other’s Lust and Vanity …”
Perhaps Mandeville thinks that feeding people’s vices is not harmful to them because vice and harm belong to different categories. If this is his reasoning, then his view that private vice is publicly beneficial is saved from incoherence, but only at the cost of utter implausibility. One does not have to believe in a soul or a god to believe that vicious traits, motives, or actions are vicious in part because they tend to undermine the agent’s peace of mind and harm her character and relationships with others. Moreover, Mandeville himself claims that people’s greed and vanity leaves them dissatisfied and unhappy, whereas when they become virtuous, they are “Blest with Content and Honesty.”
But Mandeville’s views are not merely of historical interest. In spite of Francis Hutcheson’s and Adam Smith’s criticisms of Mandeville, the conflation of self-interest with greed is common even now. In a six-part series on greed and business, John Stossel and some of his guests identify greed in business with the profit motive and claim that greed is good for a flourishing economy. Like Mandeville, Stossel doesn’t pause to distinguish greed from rational self-interest or to ask if greed is consistent with honesty and integrity.
In various TV appearances, even Milton Friedman has responded to the claim that people in capitalist societies are greedy with the words, “Isn’t everyone?” — before going on to point out that capitalist societies are the only societies that have raised the masses from poverty. This conflation of greed with self-interest harms the cause of free markets because greed is ineluctably associated with the image of an ugly, short-sighted man with two grasping hands. And rightly so, because the idea of an inappropriate love of money (or power) is part of the very meaning of greed.
The Purposes of Business
Another widely-held thesis that feeds into this unlovely image of business is that the only social responsibility of business is to increase its profits (Friedman, “The Social Responsibility of Business is to Increase its Profits”). In spite of its title, Friedman’s argument in this essay is directed not at all businesses, but only corporations. His main contention is that it’s wrong for corporate executives to discharge their “social responsibilities” by using shareholders’ money without their consent or engage in any “social” activity even with the shareholders’ consent if it doesn’t contribute to the corporation’s long-term success. The only purpose of a corporation is to maximize its profits by engaging “in open and free competition without deception or fraud."
Entrepreneurs start businesses in order to make money by doing something that inspires them.
In a debate with Friedman, however, John Mackey points out that this view fails to recognize that businesses are created by entrepreneurs for all kinds of purposes, purposes of which investors are aware before they invest in the firm. From the entrepreneur’s point of view, profits are a means to the fulfillment of a company’s purpose, not the end.
Mackey has a point. Henry Ford’s aim in creating his company was to make a good quality, affordable car, not simply to make a profit any-old-how. Profit enabled him to keep innovating and producing better and better cars. The thesis that the only purpose of business is to make a profit is analogous to the thesis that the only purpose of a novelist is to write novels that sell, or that the only purpose of a doctor with a private medical practice is to make a lot of money.
But must we choose between Friedman’s and Mackey’s descriptions of a company’s purpose? I think not. There is a third alternative: profit is a means of producing the good the business was created to produce, and the good is a means to making a profit. Entrepreneurs start businesses in order to make money by doing something that inspires them, or engages their interest, or at least fits their skill set. The substantive goal of a business, the one that differentiates one business from another, is the product it exists to create or sell.
If you ask your friend why she opened a garden center, given that it’s expected to make less money than, say, a café in that spot, she is not answering your question if she says, “In order to make money.” This is the right answer to the question for those shareholders or employees who don’t care about the product, but not, typically, for the entrepreneur or the initial investors in the company.
Omitting the fact that businesses exist in order to make or sell a good or service leaves us with the “soulless” view of business that partly explains why business people are held in low regard by society as money-grubbers. The mere fact that people tend to be suspicious of those who make a lot of money doesn’t fully explain this low regard, since people in other professions who earn big bucks and own multiple mansions, such as Hollywood actors or athletes or rock stars, are not held in low regard.
“Market” Virtue
In recent years, economists have written defenses of market activities and market societies in virtue-ethical terms. Sometimes, however, they end up supporting this soulless view of business. A case in point is the well-meaning defense by Luigino Bruni and Robert Sugden of what they call the “market virtue” of respect for one’s trading partners’ tastes. They argue that this market virtue implies that the manufacturer or seller ought not to patronize the customer by making or selling only what he is intrinsically motivated to make or sell. The business person should treat his trading partner as an equal. Hence, if he is a craftsman or professional, he might have to compromise his standards of excellence when he engages in market transactions. And this is justified, according to Luigino and Sugden, because market exchange has its own standards of excellence. The customer is always right.
But is respect conceived thus a virtue? And how can the manufacturer or seller be equal to the customer if he has to compromise his standards to please the customer? The attitude that Bruni and Sugden recommend is compatible with equality and mutual respect if the product in question is just a matter of taste such as blue walls or Berber carpets or sour candies. There is no reason why the producer should not cater to his customers’ tastes because pleasing their taste is the whole point of producing a variety of paints, carpets, or candies.
Business activities are neither inherently soulless nor inherently greedy.
But surely crafts and professions involve more than just would-be customers’ tastes. They involve standards of excellence that the craftsperson or professional must meet out of self-respect and respect for her craft or profession. The attitude Bruni and Sugden endorse entails that Howard Roark, the famous hero of The Fountainhead, was wrong to refuse to build buildings without integrity in order to please his customers. By the same logic, it entails that, qua business people, novelists are wrong to refuse to write formulaic novels guaranteed to sell well just because they don’t meet the novelists’ standards, and actors are wrong to refuse roles in movies expected to be box office hits just because they violate their artistic standards. In short, Bruni and Sugden’s thesis entails that integrity is incompatible with market transactions, an implication that they themselves would surely not welcome.
But there is no reason to accept their premise that the standards of excellence for market exchange may require compromising the standards of excellence for craftsmanship and professionalism. When Roark explains to his customers why he doesn’t build buildings that are a hodge-podge of styles from different centuries, styles that no longer serve the purpose they once served, he treats both his customers and himself with respect.
A final problem is the tendency among utilitarian defenders of free markets to whitewash the behavior of businesses when they actually do greedy and unjust things by pointing to the benefits they produce for society and blaming the law or the government for their injustice.
For example, it is sometimes said that if the government uses the doctrine of eminent domain to seize someone’s property without her consent, or without due compensation, in order to help a business, the fault is the government’s, not that of the business. But if the government’s actions are instigated by a business, how can it not be the fault of that business as well? No one is forcing the business to induce the government to make a land grab on its behalf. The business’ responsibility to maximize profits is meant to be constrained by the demands of justice. In India, such land grabs are one of the reasons that thousands of farmers have committed suicide in recent decades.
Business activities are neither inherently soulless nor inherently greedy. Indeed, widespread prosperity requires entrepreneurial passion, innovation, rational self-interest, and trust, and trust requires justice, honesty, and integrity. Defenders of free markets must recognize this if they wish to succeed in defending them.
Neera K. Badhwar is Professor Emerita of Philosophy at the University of Oklahoma, where she taught from 1987-2010, and an affiliate at George Mason University.
This article was originally published on FEE.org. Read the original article.
Patient Capital Management: Equity valuations are approaching bubble like levels. As in every other period of excess, market sentiment is buoyed by proclamations of further gains and the fear of loss is replaced by the greed for more gains.
See full Vito Maida’s Patient Capital Management – Q2 2014 in PDF format here.
Mawer Funds 2014 annual letter titled, “The Prince That Never Dies.”
Mawer Funds – The Prince that Never Dies
The Case Of Dmitry Ivanovich
Medieval Europe was not an easy era to be the heir of a feudal lord; it was not uncommon for a claimant to be made to disappear.
To the enterprising, however, a disappearance was a prime opportunity for career advancement. Born a meager nobleman? Not a problem. Simply persuade the people that you are the missing Lord or Prince and, when you ascend the throne, get rid of anyone who would say otherwise. It was remarkable how quickly the public could forget the past. And yet no case was more unbelievable than that of the three Dmitrys, which occurred between 1603 and 1611, when no fewer than three men claimed to be the resurrected Dmitry Ivanovich, third son of Ivan “The Terrible” of Russia.
The case of the three Dmitrys transpired because of an act of evil committed by the Russian boyar, Boris Godunov. A cunning man with a long, dark beard and an unquenchable thirst for power, Godunov was the brother-in-law of Feodor I, the second son of Ivan “The Terrible.” Originally in Ivan’s inner circle, Godunov was a brilliant strategist who was ruthlessly addicted to power. When Ivan IV died and Feodor I became tsar, Godunov used the youth’s mental illness to become the behind-the-scenes ruler of Russia.
Since Feodor I had no direct heirs, Godunov’s only threat to absolute rule was nine year old Dmitry Ivanovich who was next in line to the throne. In order to secure his future as tsar, Godunov needed to take care of Dmitry. He had the little boy murdered and elected himself as Feodor’s successor.
But Godunov’s problems with Dmitry were only beginning. In 1600, rumours began circulating that the young prince had miraculously survived the assassination attempt and had risen again! On cue, in 1603, a young man came forward claiming to be the missing prince. His story proclaimed that Godunov had mistakenly murdered another boy in his place, and he had travelled from monastery to monastery to avoid capture. False Dmitry I was not only able to gain the sympathies of the Russian public, but of England as well. It was this widespread support that enabled him to acquire an army of his own and eventually become tsar. Not bad for an upstart with no real royal blood. Regrettably for this Dmitry, his reign as tsar would be cut short by Godunov allies who disagreed with the appointment.
“…as the fear of uncertainty declines and jealousy and greed takes over, asset classes perceived as “riskier” are becoming more popular again.”
Dmitry Ivanovich would miraculously rise not once, but twice, after this. This was crazy. Not only were all three imposters ambitious enough to fake a royal identity, but the Russian public was willing to believe in each subsequent resurrection as well. As the False Dmitrys demonstrate, people will believe what they want and are quick to forget the past.
This apparent shortness of memory is a lesson seasoned investors know well. Even after a market collapse, when investors feel the sting of losses keenly and become hesitant, there comes a time when investors acquire the stomach for risk again. It does not matter how much pain the last crisis caused. Risk appetite eventually returns.
The past year appears to have marked the return of risk appetite. Nearly four years after the U.S. subprime market burst, triggering a near meltdown of the financial system and a global recession, the shock finally appears to be wearing off. Investors are forgetting 2008/2009. And as the fear of uncertainty declines and jealousy and greed take over, asset classes perceived as “riskier” are becoming more popular again.
The return of risk appetite is evident on a number of fronts: equities are now at or above long-term average valuations; low quality borrowers are raising debt in public markets at a rapid pace; and synthetic products like collateralized debt obligations (CDOs), the very products that helped undermine the financial system five years ago, have re-emerged. Even Cinda, the state-backed bank in China that takes on bad Chinese loans, was able to go public with huge interest from investors who were trying to gain exposure to China’s bad loans.
The renewed confidence can also be seen by looking at the nature of equity returns last year. In 2013, all of the Mawer equity mandates produced double-digit returns – our small cap mandates even generated over 40% each. How could this be possible in a year of lackluster economic growth and mediocre corporate earnings? While it would be great to say that all our equity investments posted stellar earnings growth, in reality, they broadly benefited from re-pricing in the market.
To some investors, the return of riskier investments may seem as crazy as Russians believing in a thrice-assassinated prince. But is this resurrection really so out of the ordinary?
We don’t think so. Risk appetite may be labelled a rational process, but in our experience it is much more a byproduct of the human condition. A human condition
that is inherently prone to cycles of behaviour.
If risk appetite truly has returned, then it is important for our clients to understand how this might affect the odds of investment success. That is why we spend some time in this year’s annual letter exploring the appetite for risk, how it evolves, and how it relates to the investment landscape. By exploring these factors, we hope our clients will be in a position to make better decisions than our 16th century Russian counterparts.
Mawer Funds – A Bet With Boris
To properly appreciate risk appetite, it is important to first distinguish between “risk” and “uncertainty.” This can be accomplished by a simple thought experiment.
Imagine you are hanging out with Boris Godunov at a coffee shop in Moscow. Ever the gambler, Boris hands you a die and offers you a deal. If you roll a 1, 2, 3, 4 or 5, Boris will pay you $50,000. But if you roll a 6, Boris gets your house and your second child. You have no idea what is going to happen when you roll, but you know you have six possible outcomes. This is risk. It happens when you know the future distribution.
Wall Street Bets was a real world example of what happens every day on a more micro scale. It shows us that, if you can in fact leverage the existing infrastructure–that is, the physical, the knowledge base, the attitudes of the people, and many other factors–you can make gains. Wall Street Bets did this: they harnessed the infrastructure of the internet and social media. Total greed ultimately took over in Wall Street Bets.
Get The Full Henry Singleton Series in PDF
Get the entire 4-part series on Henry Singleton in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues
Further, this event happened on the heels of an insane year--unlike anything we have ever experienced. People were already in a state of disbelief, distrust, and questioning the system, the banks, etc.
The Long-Term Effects Of Wall Street Bets
WSB proved to provide a bit of relief from this tension, especially for all of the people who believe in reptiles that rule the countries, who felt vindicated about their theories. The Wall Street Bets leaders had ideas about how the financial system works.
But, nobody can predict the long-term effects of Wall Street Bets. The ones who made money were in early, and then exited the trade. Perhaps they were laughing at the mania they started. Who knows? WSB went the way of all pumps and dumps. The big difference was the scale. WSB took place in such a manner for all to see. The same thing happens on a small scale every day.
As the WSB GameStop situation unfolded, greed came together, and the price went parabolic. For a short time, everyone was happy. Until the price collapsed, and many of the followers left holding the bag. Then, WSB reportedly turned their attention to silver. Many analysts believed the silver price could go bonkers. Even from a technical analysis perspective, silver seemed ready to spike, and many believed it would. The greed in the silver market skyrocketed.
So, attention was now on a market seemingly ready to go parabolic. Everything seemed aligned. But, this time it was not some obscure Reddit page that nobody knew about. The world was watching, and everybody knew what was happening. Certain traders probably prepared. People bet against WSB. You saw the dollar strengthen, and JPMorgan downgraded the sector.
GameStop And Silver Squeeze
The WSB situation entailed some people with ideology and some pertaining goals. That’s cool. They weren’t evil. They had an ideological goal. But, the people who followed were largely acting on greed. When it came to the attempted #silversqueeze, greed was ultimately trumped by greater greed.
WSB’s squeeze on GameStop and attempted squeeze on silver demonstrated how markets are fluid and evolving. Just because you struck a blow against a hedge fund, doesn’t mean that opportunity will be there tomorrow. The WSB movement, by having such success, likely destroyed itself in the process. That’s how things go. It’s a real world, clear example of basic behaviors of man.
In the aftermath, the markets have in many ways remained more stable than I expected. WSB has not had the consequences many people seemingly thought it would. And, although the world of traders got clear evidence how markets are rigged, they still throw their money at Wall Street.
Article by Thierry Gilgen, CEO of MachinaTrader
About the Author
A seasoned trader and CEO of automated trading platform MachinaTrader, Thierry Gilgen has highly infectious motivational energy in the trading industry. With years of experience in forming startups and understanding the hurt points of enterprises, he provides insights based on his experience. From starting from garage path lifestyle and selling websites from at home during his teenage years, his goal is to provide valuable insight to the finance industry and share his thoughts on how to build successful businesses.
